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Tournaments versus Piece Rates under Limited Liability

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  • Kräkel, Matthias

Abstract

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004The existing literature on the comparison of tournaments and piece rates as alternative incentive schemes has focused on the case of unlimited liability. However, in practice real workers’ wealth is typically restricted. Therefore, this paper compares both schemes under the assumption of limited liability. The results show that if the cost function is sufficiently convex, first-best effort will be more likely implemented under piece rates than under tournaments. Moreover, if first-best implementation is not achieved and workers earn positive rents, efforts and profits will be larger for piece rates than for tournaments given sufficiently convex costs. While tournaments offer a partial insurance due to their fixed prizes, piece rates may not work any longer if potential losses become prohibitively high. Finally, if risk is sufficiently high, piece rates will dominate tournaments despite the partial insurance effect of tournament compensation. Since effort costs and risk may depend on an individual worker’s characteristics, on the characteristics of his job and on his hierarchical position, these findings have important implications for the choice of incentive schemes and the allocation of workers in firms.

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Bibliographic Info

Paper provided by Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems with number 15.

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Date of creation: Jul 2004
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Handle: RePEc:trf:wpaper:15

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Keywords: incentives; limited liability; piece rates; rank-order tournaments;

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  1. Pitchford, Rohan, 1998. "Moral hazard and limited liability: The real effects of contract bargaining," Economics Letters, Elsevier, vol. 61(2), pages 251-259, November.
  2. Ronald G. Ehrenberg & Michael L. Bognanno, 1988. "Do Tournaments Have Incentive Effects?," NBER Working Papers 2638, National Bureau of Economic Research, Inc.
  3. Richard B. Freeman & Morris M. Kleiner, 1998. "The Last American Shoe Manufacturers: Changing the Method of Pay to Survive Foreign Competition," NBER Working Papers 6750, National Bureau of Economic Research, Inc.
  4. Son Ku Kim, 1997. "Limited Liability and Bonus Contracts," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 6(4), pages 899-913, December.
  5. Edward P. Lazear, 1996. "Performance Pay and Productivity," NBER Working Papers 5672, National Bureau of Economic Research, Inc.
  6. Malcomson, James M, 1986. "Rank-Order Contracts for a Principal with Many Agents," Review of Economic Studies, Wiley Blackwell, vol. 53(5), pages 807-17, October.
  7. Green, Jerry R & Stokey, Nancy L, 1983. "A Comparison of Tournaments and Contracts," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 349-64, June.
  8. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-64, October.
  9. Malcomson, James M, 1984. "Work Incentives, Hierarchy, and Internal Labor Markets," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 486-507, June.
  10. Bull, Clive & Schotter, Andrew & Weigelt, Keith, 1987. "Tournaments and Piece Rates: An Experimental Study," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 1-33, February.
  11. Baker, George & Gibbs, Michael & Holmstrom, Bengt, 1994. "The Wage Policy of a Firm," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 921-55, November.
  12. Knoeber, Charles R & Thurman, Walter N, 1994. "Testing the Theory of Tournaments: An Empirical Analysis of Broiler Production," Journal of Labor Economics, University of Chicago Press, vol. 12(2), pages 155-79, April.
  13. Baker, George & Gibbs, Michael & Holmstrom, Bengt, 1994. "The Internal Economics of the Firm: Evidence from Personnel Data," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 881-919, November.
  14. Dominique Demougin & Claude Fluet, 2003. "Inequity Aversion in Tournaments," Cahiers de recherche 0322, CIRPEE.
  15. Park, Eun-Soo, 1995. "Incentive Contracting under Limited Liability," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(3), pages 477-90, Fall.
  16. Eriksson, Tor, 1999. "Executive Compensation and Tournament Theory: Empirical Tests on Danish Data," Journal of Labor Economics, University of Chicago Press, vol. 17(2), pages 262-80, April.
  17. Bognanno, Michael L, 2001. "Corporate Tournaments," Journal of Labor Economics, University of Chicago Press, vol. 19(2), pages 290-315, April.
  18. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
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Cited by:
  1. Clark, Derek & Konrad, Kai A., 2006. "Contests with multi-tasking," Discussion Papers, Research Unit: Market Processes and Governance SP II 2006-14, Social Science Research Center Berlin (WZB).
  2. James W. Bono, 2008. "Sales contests, promotion decisions and heterogeneous risk," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 29(4), pages 371-382.
  3. Gerald Eisenkopf, 2006. "Deterring gaming with imperfect evaluation methods," Working Papers of the Research Group Heterogenous Labor 06-04, Research Group Heterogeneous Labor, University of Konstanz/ZEW Mannheim.

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